To my surprise I have found myself following a rather economics-heavy debate on overinvestment in China recently. I’m interested because of my forthcoming e-book project. One of the chapters will be on Japan’s economic miracle. Apart from pondering investment to GDP ratios I was wondering: can we compare today’s China with post-war Japan?
House in Hangzhou, China
I looked at China’s growth a lot in my previous incarnation as a researcher for a large asset manager so I picked up a recent study by the IMF with interest. It argues that China is reaching dangerously high investment levels and needs to shift its growth away from this investment to more consumption.
The debate is already quite old, with China hawks using the overinvestment story as their main argument in favour of a coming slowdown, if not crash in some people’s books.
The simplified theory goes that with ever-growing investments (as a share of national income, or GDP), the quality of these investments is decreasing (think bridges to nowhere, ghost towns).
Yet in order to maintain economic growth rates in the absence of large-scale consumption or export growth, investment has to grow commensurately to keep the machine humming at above 8% GDP growth per year (seen by many as the minimum rate of growth to accommodate labour market entrants, although that number is coming down gradually as population growth declines). This in turn leads to ever more wasteful spending.
Once addicted to (often government-directed) investment spending, especially in the case of global economic headwinds, it is difficult to wean yourself off it without upsetting your economy or politics at least temporarily. The Soviet Union, many people argue, went under because of such wasteful and persistent overinvestment in the face of falling global oil prices in the early 80s.
The analogy is tempting, because in China you also have an authoritarian government that can simply “decree” certain imbalances away for a period of time, e.g. by suppressing financial intermediation and the signalling power of interest rates by effectively telling banks at what rates to lend and borrow. At the same time, it proves hesitant to “liberalise” in certain areas with good growth prospects but contentious political ramifications (e.g. education and rural land reform).
Yet China is also proving to be a paradox: It has posted growing investment to GDP / gross capital formation, year after year. It now invests roughly half of its GDP. Japan at its peak invested 40%. Why is China different, i.e. why can it invest for so long without there being a crisis of confidence?
Many scholars have put forward their explanations. For one, China is still very poor, so sustained high investments can co-exist with a still low per capita capital stock. There is a lot of opportunity for investment if two out of five villages have no paved road access. And while there undoubtedly is wasteful spending, you have many years to go before you run out of investment opportunities altogether.
This goes alongside some very interesting arguments from spatial economics that tell us why China may be different from other countries in the past (its unique size, population distribution, development corridors, etc. mean that we are looking, in fact, at several different countries). I’m not quite sure where I stand on this, but I think bears have their point.
Anyway, this debate simply is so huge that a single blog post can’t do it justice. What I wanted to do though is look at how Japan’s experience in the 1950s and 1960s compares to that of modern China.
The Economist had a long article about this topic in early 2010. In economic terms, China’s per capita GDP today as a share of US per capita GDP roughly represents that of Japan back then. Thus, the article argues, we (and Beijing’s policymakers) shouldn’t look at the 1980s Japan for comparison with today’s China, but to the 1960s. In this reading, China’s day of reckoning may still be a while.
The Economist article doesn’t insinuate that Japan’s boom in the 1950s and 1960s is analogous to China’s recent growth spurt. However, I was thinking that the differences between the two “miracles” are probably worth spelling out, if only for my own training.
There seems to be some kind of common sense in the assumption that China will eventually “out-miracle” Japan. Some caution may be warranted. After all, the widely predicted Japanese Century did not materialise either.
Some starters (and by no means an exhaustive list!):
- Chinese exports account for almost a third of GDP today, Japan’s back then did for roughly 10%. This means that the composition of Japanese GDP was very different: A smaller gross capital formation ratio at its peak than in China coupled with lower exports mean that consumption accounted for a much larger share in Japan than in China. Unsurprisingly, consumption consistently constituted more than half of Japan’s GDP growth in the 50s (66.8%) and 60s (56.3%). Only recently has consumption accounted for more than 50% of GDP growth in China. It will need to sustain that in order for a rebalancing to happen.
- Not unrelated to the above is the fact that more people could share in that consumption (and its growth) as income inequalities were much lower in Japan back in the 1950s/1960s than in today’s China. Japan’s Gini coefficient hovered around 0.35 throughout the 1960s (a “reasonable” wealth gap), whereas in China today it lies anywhere between 0.45 and 0.50 (approaching “socially dangerous” levels). Of course this depends on your available data: the Chinese government has refused to publish Gini coefficients for the last ten years.
- Japan was lucky to be the first East Asian economy to catch up with the West. Meanwhile, new barriers to emerging economies have appeared: more trade liberalisation has made infant industry protection as well as other industrial policy tools harder to employ. Technologically, the world has moved ahead fast and technology adoption is now much harder than in the 1960s. In turn, this has arguably made avoiding the “middle-income trap” harder.
- Perhaps it can also be argued that Japan back in the 1950s and 1960s moved more swiftly on increasing social expenditures than China does today. Japan’s social security spending already stood at 6% of GDP in 1960 and grew to 11% in 1985. China’s figure today is around 2-3%. The differences for education and health spending are not as obvious, but show that Japan in 1960 was already as far if not a little farther down the line there, too. In order to “track” Japan’s economic miracle in the important social spending bracket, China will have to move rapidly, something not quite obvious at least politically.
- While their importance has declined when looking at their overall contribution to GDP, China’s economy is still dominated by state-owned enterprises. They share some features with the keiretsu of Japan, such as preferential access to credit and a general opaqueness surrounding some of their activities. However, it should probably be argued that Chinese SOEs are by their nature political entities, often staffed with top-ranking CPC officials. The discerning feature of Japan’s post-war bureaucracy is probably that its elites were insulated from corporate interests, i.e. the state wasn’t captured by powerful and rent-seeking private sector players.
- One of the biggest but also contentious differences between Japan in the 1950s/60s and China today relates to how far ahead the government and bureaucracy can credibly formulate long-term policies. Japan’s Ministry of Finance and MITI were (at least partly) behind very well coordinated investments in strategic industries that took decades to come to fruition. All the while, they avoided capture by powerful interest groups. Recent revelations about China’s elite cashing in on economic growth cast some doubt on whether this can still be the case in China. This point I will explore in a separate posts, as it will probably be at the heart of my work on Japan’s post-war economic recovery.
The biggest problem with all these arguments is that it relies on China’s official statistics. This country has perhaps the most unreliable statistics in modern economic history. What is considering consumption, investment, etc are all over the map. There is also evidence indicating that many activities (especially the service sector) are not captured in the official data. Anyone who thinks they really know what is going on (regardless of bullish or bearish arguments) is just fooling themselves as it is really nothing but academic exercise. Not even god knows what is actually going on.
Good point Ben – yet I think that poor data quality is not only a concern in China. In the same vein, we need to read historical data from Japan with some caution. Data cannot tell us the whole story but needs to be but one piece of the puzzle.